Unfortunately for some shareholders, the Eastman Chemical (NYSE:EMN) share price has dived 38% in the last thirty days. That drop has capped off a tough year for shareholders, with the share price down 41% in that time.
All else being equal, a share price drop should make a stock more attractive to potential investors. While the market sentiment towards a stock is very changeable, in the long run, the share price will tend to move in the same direction as earnings per share. The implication here is that long term investors have an opportunity when expectations of a company are too low. Perhaps the simplest way to get a read on investors’ expectations of a business is to look at its Price to Earnings Ratio (PE Ratio). A high P/E implies that investors have high expectations of what a company can achieve compared to a company with a low P/E ratio.
Does Eastman Chemical Have A Relatively High Or Low P/E For Its Industry?
Eastman Chemical’s P/E of 8.38 indicates relatively low sentiment towards the stock. If you look at the image below, you can see Eastman Chemical has a lower P/E than the average (16.0) in the chemicals industry classification.
Eastman Chemical’s P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with Eastman Chemical, it’s quite possible it could surprise on the upside. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
How Growth Rates Impact P/E Ratios
Companies that shrink earnings per share quickly will rapidly decrease the ‘E’ in the equation. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. Then, a higher P/E might scare off shareholders, pushing the share price down.
Eastman Chemical shrunk earnings per share by 28% over the last year. But it has grown its earnings per share by 2.0% per year over the last five years. And EPS is down 1.6% a year, over the last 3 years. This could justify a low P/E.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. So it won’t reflect the advantage of cash, or disadvantage of debt. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).
How Does Eastman Chemical’s Debt Impact Its P/E Ratio?
Eastman Chemical’s net debt is 89% of its market cap. This is a reasonably significant level of debt — all else being equal you’d expect a much lower P/E than if it had net cash.
The Bottom Line On Eastman Chemical’s P/E Ratio
Eastman Chemical’s P/E is 8.4 which is below average (13.8) in the US market. Given meaningful debt, and a lack of recent growth, the market looks to be extrapolating this recent performance; reflecting low expectations for the future. What can be absolutely certain is that the market has become more pessimistic about Eastman Chemical over the last month, with the P/E ratio falling from 13.6 back then to 8.4 today. For those who prefer to invest with the flow of momentum, that might be a bad sign, but for deep value investors this stock might justify some research.
Investors should be looking to buy stocks that the market is wrong about. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
But note: Eastman Chemical may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
If you spot an error that warrants correction, please contact the editor at email@example.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.
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